Experts: How to Fix the U.S. Retirement System

Money mavens offered these ideas at a Senate hearing today

The bright spotlight on improving America’s rickety retirement system glared in Washington, D.C., today as the Senate Finance Committee held a hearing called “Retirement Savings 2.0 — Updating Savings Policy for the Modern Economy.”

The experts who testified, ranging from Vanguard mutual funds founder and former CEO Jack Bogle to Harvard professor Brigitte Madrian, offered their best ideas to help Americans save more and make it through retirement without becoming destitute.

A Bipartisan Plan

Some echoed what Chris Farrell, author of the new book Unretirement, called for in his recent Next Avenue piece, “4 Ways to Fix the U.S. Retirement System.”

You might see some of today’s proposals eventually become law, since Senate Finance Committee Chair Ron Wyden (D-Ore.) invited the money mavens to help Sen. Orrin Hatch (R-Utah) and him assemble a bipartisan plan to reform America’s retirement system. (Some observers, such as Forbes’ Ashlea Ebeling, saw the hearing as evidence that Congress is targeting retirement tax breaks.)

Is There a Retirement Crisis?

Before I mention the most intriguing ideas offered today, I need to note that three of the experts essentially said there is no retirement savings crisis in America.

These men — Brian Reid, Chief Economist of the Investment Company Institute (the mutual fund trade group); Scott Betts, Senior Vice President of National Benefits Services, which designs and administers retirement plans and Andrew Biggs, Resident Scholar of the American Enterprise Institute think tank — maintain that many, if not most, people are in tiptop financial shape.

“While there is room for improvement, the retirement system is working for millions of American workers,” said Reid. His group takes issue with the oft-cited statistic that 57 percent of all full-time private-sector wage and salary workers (or 80.6 million) had pension coverage in 2012 and says there are only 10.2 million “who are likely to desire to save for retirement in the current year and who do not have access to an employer plan through their own employer or a spouse.”

Betts was more emphatic, saying “the current system works” and “should be viewed as a success.” And Biggs was even more blunt: “Americans do not face a ‘retirement crisis,’” and “the best forecasts do not show retirement security declining significantly as the Baby Boom and Gen-X generations retire.”

The Experts' Recommendations

All the experts believed, however, that the current system could be better. Here are their recommendations:

Vanguard’s Jack Bogle: The father of index funds and a huge proponent of keeping investing expenses low was the gloomiest of the bunch. Bogle said: “Today’s system constitutes, if you will, a three-legged stool, and all three legs are faltering.” (The three legs: pensions; Social Security and retirement savings plans; he had ideas for each.)

Bogle said public and private pension plans are not only underfunded by hundreds of billions of dollars, virtually all of them assume overly optimistic future investment returns of about 8 percent a year. He calls that “absurd” since U.S. Treasury bonds yield around 3 percent and, he believes, future stock returns seem likely to be in the 7 percent range. With those returns, a balanced portfolio would earn more like 5.5 percent (before fees). His advice: increase pension funding and make expectations for future returns realistic.

For Social Security, Bogle said, we need to: gradually hike the maximum income subject to the payroll tax (now $117,000); tweak the benefit formula to one tied to inflation; raise the retirement age to, say, 69 and institute a “modest” means test to limit payouts to the wealthiest. In short, said Bogle, Social Security needs to be enhanced for the lowest-income Americans.

Retirement savings plans, such as 401(k)s give employers and individuals “too much flexibility,” Bogle said. Specifically: 20 percent of eligible participants don’t sign up; hardship withdrawals are granted too easily; loans aren’t strict enough and you can get your money when you switch jobs. He thinks all of those problems should be, and can be, fixed — through more automatic enrollment and tighter restrictions on getting your retirement savings before retirement.

Like Farrell, Bogle says the $385 billion federal Thrift Savings Plan (TSP) — which the Senators are eligible for — is a model of a retirement savings plan that works to help employees reach their goals. It keeps costs low, largely through index funds, and the plan is generous. Participants can invest up to $17,500 a year, with 3 percent of their pay automatically deducted unless they opt out. There’s also an employer match of up to 4 percent.

Brigitte Madrian, Aetna Professor of Public Policy and Corporate Management at Harvard Kennedy School and expert on savings behavior, said the tax code’s complexity is a savings disincentive. “If you want individuals to save, make it easy,” she said.

Her research has found that most people don’t understand the tax implications of saving in a Roth 401(k) or Roth IRA vs. a traditional version, for example. Madrian added that individuals are more responsive to immediate financial incentives, yet many benefits for retirement saving (like tax-deferred compounding) are delayed.

Her recommendations: more automatic enrollment in savings plans; raising the number of small businesses offering savings plans by creating simple, low-cost versions and providing simple savings alternatives for the self-employed and for those whose employers are unlikely to ever offer a savings plan.

Like Bogle, Madrian wants to see Congress tighten the retirement plan faucet to curtail leakage — pre-retirement withdrawals and loans — by increasing penalties on such withdrawals, limiting the size of the withdrawals and giving people more time to repay the loans after they leave their jobs.

Andrew Biggs was another fan of automatic enrollment in retirement saving plans, calling it “probably the single most effective step we could take to increase retirement savings.” He, too, is an index funds proponent, and said that focusing pension offerings on low-cost index funds could be of great benefit to savers.

But his Social Security proposal was somewhat radical. Biggs wants Social Security to pay a “universal, flat benefit” to all retirees, regardless of their earnings or workforce participation. He concedes that this would mean middle- and high-income workers would need to save more on their own.

Scott Betts endorsed Sen. Hatch’s “starter 401(k) plan” idea, saying it would give employers that don’t have 401(k)s a less expensive option to provide a substantial retirement benefit for their employees. It would let you save up to $8,000 a year — more than a traditional IRA ($5,550; $6,500 if you’re 50 or older), but less than a 401(k)’s $17,500 limit ($23,000 for those 50 or older) — and wouldn’t require employers to contribute.

Brian Reid pushed greater financial literacy about retirement plans and a new plan for small businesses. His group urged Congress to promote electronic delivery of plan information, interactive educational tools and materials for employees. The introduction of a new type SIMPLE plan for small employers (which would not require employer contributions) would encourage greater plan creation and coverage at their workplaces, Reid said. The plan would let employees contribute more than traditional and Roth IRAs but less than current SIMPLE plans ($12,000).

So, basically, it comes down to simplicity, SIMPLEicity, lower costs and more automatic enrollment. Let’s see if this is change Washington can believe in.